Bruce Stuart: What impacts business profitability in the cloud

Profitability in the recurring revenue, cloud, SaaS and MPS business is not driven by the same drivers as the on premise business?

Account loss rate or churn has a huge negative impact on the profitability of a cloud or SaaS business.  When an account is lost an equivalent revenue stream must be acquired in order to maintain the size of the business.  If the rate of account loss (or the amount of revenue lost in a period) exceeds the rate of account acquisition (or the amount of contract revenue gained in a period) the profitability of the business will fall.   Because the recurring revenue of existing accounts pays for the cost of acquiring new accounts, loss of the existing accounts puts downward pressure on the profit model.

Transaction size or deal size impacts the profitability of a cloud or SaaS business.  Larger transaction sizes mean fewer transactions to generate a given amount of revenue. Due to the fact that marketing and sales costs do not generally vary by transaction size outcome, successful engagement in larger transactions generally results in lower account acquisition costs (marketing and sales costs) higher initial account profitability and faster break even times on the account and the entire business.

Transaction acquisition cost, mainly marketing and sales related, also impacts the profitability of a cloud or SaaS business.  Assume an extreme case scenario where the transaction revenue does not meet the cost of acquiring an account. In this situation the account would never make a contribution to fixed cost, let alone make a contribution to profit.

Transaction count and the growth of transaction counts have a major impact on the profitability of a cloud or SaaS business.  This metric is related to the requirement to manage churn or account loss.  If for example a business is losing members of their account base at the rate of ten percent per year, but is acquiring new (perhaps larger) accounts at the rate of 15 per cent per year, profitability of the business will be maintained and will in fact grow if the account retention cost stays constant or drops.

Account retention and support costs are also related to the profitability of a cloud or SaaS business.  Ongoing account contribution to fixed cost and profit is equal to the account period revenue less the period account retention and support costs.  By reducing the account retention and support costs the contribution of the account to fixed costs and profit increases.

How long does it take to make money in the cloud?  At Channelcorp we use the cloud-based business planning solution LivePlan to calculate the answer to this question. The answer to this question depends a lot on the way you want to enter the recurring revenue business and the scope and scale of the investment that you want to make. We have reviewed a range of projections from a number of vendors, completed our own projections and discussed this point with a number of businesses that have made the investment and the transition. The “commonly held belief” in the business seems to be convergence on the period of 15-36 months (5-9 quarters) until the cloud or SaaS business generates accounting profits and 24-48 months (8-16 quarters) until the business has generated positive cash flow on a cumulative basis.  Once again we suggest that you spend a significant amount of time financial modeling and business planning before committing to major investments in your cloud, SaaS and recurring revenue businesses.

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About Channelcorp

Margaret and Bruce Stuart founded Channelcorp in 1989.  The firm is a global leader in the assistance of reseller, distributor and vendor clients. Channelcorp specializes in the business model transformation that is required in the face of the structural changes to recurring revenue driven business models in the worldwide IT business (www.channelcorp.com/services.php).  Channelcorp publishes and sells four industry- leading books and 12 white papers (www.channelcorp.com/publications.php).  

 

 

 

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Jim Love, Chief Content Officer, IT World Canada

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